China-US trade war has elevated FX risk up FDs’ agendas

The global financial crisis provided a common enemy for Western governments, leading to a largely unified approach with countries agreeing on various stimulus packages.

While not out of the woods yet, the immediate danger has passed and with it the previous consensus of how to deal with the fragile economic environment.

This new approach has culminated in a heated trade row between the US and China. The US has accused China of keeping the yuan artificially low to boost exports, while the US decision to enter into another round of quantitative easing has enraged the Chinese.

Many economists have warned that this export-boosting strategy and potential currency war could lead to exchange rate volatility and protectionism. Europe finds itself caught in the middle.

Paul Tabberner, regional director, large corporate London and the south east in Lloyds Banking Group’s financial markets team, says this has become a driving concern for finance directors.

“We have seen a pick-up in demand for managing foreign exchange risk this year,” says Tabberner. “Not only has the spot market become volatile, the implied volatility of future rates is elevated. People managing that risk using future options now have different risks to consider. A lot of businesses see foreign exchange volatility as the main driver for future risk.”

The G20 Summit in Seoul in November failed to tackle the deadlock between the US and China. The swings in foreign exchange rates have been hitting exporters, while another symptom of the currency volatility has been the decline of the US dollar and the rise in commodities prices.

The uncertain future has made finance directors look again at the hedging instruments they have in place for a whole host of different risks that have been affected by the volatility in the economy.

Tabberner says FDs are looking at everything from simple risk management tools to third-generation foreign exchange and interest rate derivatives, though most, surprisingly, stick to the most basic tools.

“The derivatives we work with are extensive and flexible. We find new ways to meet client requirements using our existing products,” he says. “But the vast majority are at the simple vanilla end. As people get more comfortable with their risks, they identify more complex solutions.”

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